Here's a stat no employer likes to think about: 30% of voluntary turnover comes down to a big bad word - compensation.
I talk a lot about employee retention and turnover, and that’s because I think when leaders focus heavily on retaining their team members, they start defaulting to ways of thinking that create healthier and more generative workplaces. I have a lot of experience dealing with this issue in what are typically high-turnover environments. I know how to maximize the simple, tiny behaviors business leaders do every day to truly build what I call a “retention culture.” I also know that it's not always necessary to change comp to improve a company's turnover problem.
However, the non-compensation related structures only take us so far. The hierarchy of needs tells us that having our physiological and security needs met must precede feelings of belonging, self-esteem, and pursuing our purpose.
Knowing that gives us as company leaders, policy makers, and advisors the opportunity to proactively choose how we’re going to use compensation to serve our employees and create competitive advantage in the labor market. Too often, employers set compensation reactively, relying on the tension between the bottom line and the lowest amount that will attract individuals to open positions to inform wage amounts. What I (and many others) propose is building a compensation philosophy, and structuring your total rewards in accordance with that.
In an ideal world, we would stop guessing and establish our compensation philosophy at the beginning of business planning.
We would take the time to decide on the factors that are important to us regarding exchanging money and other remuneration to the people who give us their most precious resources - their time and energy.
We would build the rewards package that is informed by our underlying values and goals, and structure our other financial choices (offers, pricing, overhead, etc) around that. This is part of the work my early-stage or scaling small business owners do in our private advisory. If you are in the business planning stage and planning to bring on staff at any point, thinking through your comp philosophy now is my recommendation!
As it stands, we’re often left with less than ideal choices when it comes to paying our team members. Franchises, for example, often do not choose the pricing and packages they can offer, so they must adjust compensation within that framework. Within this world of sub-optimal choices, what can we do?
Several years ago, the company I was working for faced a serious recruitment problem. It was about a year after the start of COVID times, and many in our industry were leaving after re-evaluating their risk tolerance for working so closely with the public. Skilled labor for our specialized roles became even more scarce than it had been prior to COVID, and the company was struggling to pay a competitive rate - using the model it had always used - given the margin constraints.
The business owner and I worked together on both a philosophy of compensation and a comp structure that reflected his values, the real-world challenges, the needs the company had for more coverage, and the competitive market. The resulting structure was something different than the company had ever tried before, but the company's hiring and employee retention began flowing in ways that were better than we could have hoped for. We had gotten creative, and it paid off.
We put a plan in place that allowed the staff to increase their pay to greater numbers than ever before while minimizing the financial strain the larger wages placed on the company’s bottom line.
This is one of the best outcomes we could have achieved, and starting with a solid philosophy was how we finally got there.
Compensation Philosophy 101
According to SHRM.org, “A compensation philosophy is simply a formal statement documenting the company's position about employee compensation. It explains the ‘why’ behind employee pay and creates a framework for consistency.”
A compensation philosophy offers you, as the business leader, the opportunity to reflect on whether your rewards actually showcase your company in a way that matches what you value and how you see the organization. It allows you to see where targeted changes will help match you to the employees that are best fits for your company. It also gives you a tool to help define what needs to be communicated to your team - not just what the compensation package is, but why you created it that way. This is a vital part of helping them understand the organization and how they are valued within its structure.
These documents are typically created by the HR department in cooperation with other executive leaders. I work with many clients who own small-medium sized businesses and don’t have an HR department. In that case this work would generally fall to the founder, or perhaps a right hand to the founder.
A compensation philosophy should answer these questions:
- What are we paying for? Skills, experience, tenure, performance, market value, potential?
- Where do we want to sit relative to the market, and does that position remain the same across roles and pay types? Lead, match, or lag?
- What can we actually afford to pay, given business conditions and competition? How much is our philosophy informed by real-world constraints?
- What motivates pay differences across different roles? Why does one role sit higher on the pay scale than another? Market scarcity, revenue impact, required skill depth, org-chart weight?
- How do we guarantee equal pay for equal work, and what counts as a legitimate reason for a difference? More than just “we don’t discriminate.” What are the actual factors that are allowed to move pay, and the ones that aren't?
- How transparent are we willing to be? Full bands published internally, ranges on request, or pay kept confidential?
- How does pay move over time? Merit, cost-of-living, promotion, market recalibration? On what cadence will this be evaluated?
- Who owns comp decisions, and where does best judgment override the structure? What's the escalation path when someone feels underpaid?
The questions above will help you as you structure your document. The format below is one way you can put this document together, complete with a "why" behind each section.
The Structure of a Compensation Philosophy
Purpose statement.
Define what the philosophy exists to do: attract, motivate, retain, reward high performers, define market position, ensure equal pay for equal work. This is the "why" in one paragraph; it’s the reason the rest of the document exists.
Strategic alignment.
Tie your compensation strategy to business strategy, competitive outlook, operating objectives, and what you can actually afford. These two things help keep each other accountable.
A philosophy that's aligned with your business goals but not with your budget isn't a philosophy, it's a wish list.
This section is also where you name your market position: are you leading, matching, or lagging the market, and does that remain true across base pay, bonus, and benefits, or does it shift by category? Note that this decision doesn't have to be one you communicate outward in the same words you use internally. How much of it you share with staff is a governance decision, not a strategy decision.
Pay alignment with job function.
Define how the job function itself determines its pay scale, and the criteria that play a role in selecting a starting point on this range. This is where you make explicit what drives pay differences across roles: market scarcity, revenue impact, required skill depth, scope of decision-making, org-chart weight. A job title alone doesn't justify a pay level; the actual function and its weight in the business does. Without a stated logic here, role hierarchies read as arbitrary rather than considered, and pay conversations become about who negotiated hardest rather than what the role actually requires.
Pay program inventory
Which positions receive which elements (base, variable comp, benefits) and how each is meant to function together to provide for the well-being of the people in the roles. Include a total inventory here, including perks and differentiators, as this will be a tool to help you communicate them to employees.
Failing to communicate the actual total rewards package means employees often don't understand everything the company has already considered and implemented as an act of compensation and care.
Side note: pay complaints are often actually pay misunderstandings, so set a few checkpoints during onboarding to revisit how team members get paid. I'd recommend you consider it another piece of training and ensure they take full advantage of their actual total rewards package.
Equal pay commitment.
Document your commitment to equal pay for equal work, with any differentials tied to legitimate, non-prohibited factors and explained as such.
Governance
Be transparent about who owns responsibility for which parts of the compensation conversation, and build out the mechanics of how the implementation actually operates over time. This section holds several related decisions that all live under the same roof:
- How transparent you're willing to be (full salaries published internally, ranges on request, or pay kept confidential) and how that decision gets communicated once it's made.
- How pay moves over time (merit, cost-of-living, promotion, market recalibration) and on what cadence.
- How often the philosophy document itself gets revisited, because the cadence for adjusting someone's pay and the cadence for re-examining your entire pay strategy are not the same.
Test Your Philosophy
Once the document is drafted, it has to survive contact with reality. Before you call it finished, run it through a few final questions.
- Can you actually explain the appropriate pieces of this philosophy to an employee in plain language? If you can't, or if your people are demonstrating misunderstanding, it isn't a philosophy yet. It's a spreadsheet.
- Does what you actually pay people match what the document says? A gap here erodes trust instantly. Imagine handing an employee a document that says "we lead the market" while their offer letter demonstrates that's clearly not the case.
- Is the program equitable? Is it defensible, and would your employees see it as fair if they read it? Is it financially responsible, meaning it holds up against the actual budget rather than an ideal one? Is it legally compliant?
If you can't answer yes to all of these, the document isn't done. Revisit the questions above and find the gaps.
Building this document isn't a formality, and it isn't something where you can just use a template.
It's personal work that lets us get creative under real constraints instead of getting defeated by them. It pushes us to remember that when it comes to pay, we're exchanging the energy of financial reward for the energy of work - with real people who need us to make truly reciprocal arrangements.
Most companies don't have an unlimited budget or an easy labor market. However, every company can have a business owner willing to name what they actually value, and a structure built around that instead of around scarcity or guesswork. That's what makes positive outcomes, like the one I recounted above, possible. Start with the philosophy, and the rest of the compensation structure has something solid to stand on.